8 little-known facts about the Roth IRA

This is a guest post by Jeff Rose, a Certified Financial Planner. Rose is also the author of Good Financial Cents, a financial planning and investment blog. He’s also working on his book entitled Soldier of Finance, which combines his military background and financial planning experience.

Most Americans want to save for retirement, but most don’t know how to start. Putting money into a savings account is ideal for short-term goals and emergency funds, but there are better investment vehicles for long-term savings. One investment vehicle that I’ve grown to love almost as much as much as I love In-N-Out Burger (keyword: almost) is the Roth IRA.

I know Get Rich Slowly has covered the Roth IRA a lot in the past, but new readers might not be that familiar with it. Besides, even though you might think you know everything about Roth IRAs, here are some facts that might be new to you.

1. The Roth IRA has been around the block

Most people don’t know that the Roth IRA is getting close to getting its driving permit, having been around for almost 14 years. It originally started with the Tax Relief Act of 1997, named after late Senator William Roth of Delaware. According to a study by the Investment Company Institute as of 2008, more than 15.9 percent of all U.S. households own a Roth IRA compared to 32.1 percent for traditional IRAs.

There are more dollars invested in traditional IRAs, but look out: In 2004, contributions to Roth IRAs were $14.7 billion, while contributions to traditional IRAs were $12.6 billion. Many suspect that with the Roth IRA conversion event of 2010 it will lead to a further influx of Roth IRA contributions. Much can be attributed to this based on when the Roth IRA conversion was made available in 1998. During that time, 1.4 million taxpayers converted $39.3 billion in traditional IRAs to Roth IRAs.

2. Contributions to Roth IRA are not tax-deductible

Unlike other retirement vehicles, such as the employee-sponsored 401(k), contributions to a Roth IRA are not tax-deductible. Contributions to your Roth IRA are made with after-tax dollars, which does not offer an immediate tax benefit, but rather one that is recognized at the time of distribution. When you take a qualified distribution from your Roth IRA, you will never pay taxes on that money.

This allows you to have access to your contributions at any time. That’s an attractive feature for those that want to save for retirement but are worried about having to pay a penalty if they need access to the money.

While you don’t get a tax deduction, you may qualify for the Roth IRA savers credit. The downside of the credit is that if your income exceeds $27,500 filing single or $55,500 married filing jointly, you don’t qualify.

3. You must meet eligibility requirements to contribute to a Roth IRA

As the Roth IRA gains popularity among retirement savers, many people fail to understand that not everyone will be able to contribute to this type of account. In order to contribute to a Roth IRA, you must fall below the established income thresholds set forth by the IRS each year. The cut-off limits (otherwise known as phase-out limits) for 2011 are $122,000 for single filers and $179,000 married couples filing jointly.

If your income falls beneath the threshold for your filing status for the year, you must also make contributions from taxable compensation. This means individuals cannot use rental property payments, royalties, or other non-taxable compensation to make contributions to a Roth IRA.

4. You may be able to convert other retirement accounts to a Roth IRA

Since 2010, there are new conversion rules that apply to the transferring of funds from a traditional IRA or 401(k) to a Roth IRA. When you convert from a tax-deferred retirement account to a tax-free retirement account, you’ll potentially see many benefits long term. It’s important to remember that the IRS isn’t going to forget about the taxation of this money. Whatever amount you transfer to the Roth IRA will be tacked on to your earned income (and taxed at your current rate) for the year of the conversion.

Please note: 2010 allowed you to split the tax bill over a multi-year period, but that expired in 2010.

5. The Roth IRA can be used for other savings goals

Usually, experts recommend that retirement vehicles be used solely for retirement purposes. However, out of all the retirement accounts on the market, the Roth IRA can be used for other goals.

Since you have already paid taxes on your contributions, you are able to enjoy tax-free distributions of those contributions (but not the earnings) before you reach retirement age. As long as all distribution requirements have been met, you may access that money for other things such as a down payment on a home or college tuition. Often times I will meet with young parents who are very ambitious about saving for the kids’ college but are barely saving anything for their own retirement. In these situations, I often suggest the Roth IRA as a viable substitute.

6. Roth IRA distributions don’t contribute to taxable earnings

One of the most attractive features of the Roth IRA is that, when you start taking distributions, you don’t have to worry about them contributing to your taxable income. This is because Roth IRA contributions grow in your account tax free. This is because you are making contributions with after-tax dollars. With a traditional IRA, you make a contribution with pre-tax dollars, so you end up with a deduction. A traditional IRA contribution lowers your taxable income.

This is not the case with a Roth IRA. You get no tax benefit immediately for making a contribution to your Roth retirement account. You pay taxes on your income, and then you make your contribution. However, because you have already paid taxes on the money you use, you won’t be taxed on it again. Your money grows tax free. For those who think that they’ll be in a higher tax bracket or that tax rates will go up by the time they retire, this can be an advantage. You pay taxes at your current, lower rate, and then when you take your distributions, you avoid paying taxes at your future higher rate.

7. There is a five-year rule for Roth IRA withdrawals

It is possible to withdraw money that you have contributed to your Roth IRA at any time, tax- and penalty-free, as long as you meet the distribution requirements. However, if you want to withdraw the earnings from your Roth IRA, it is important to realize that you must have the account for at least five years. The clock starts ticking from the first day of the tax year in which you designate your contribution. So, if you open your Roth IRA in September of 2011 and make your initial contribution, you can make withdrawals of your earnings starting 01 January 2016.

This also works if you open your Roth IRA before April 15th and designate the contribution for the previous year. For example, you can open a Roth IRA on 10 April 2012, and designate 2011 as the year for your contribution. The clock starts ticking on 01 January 2011, even though you opened your IRA in April.

The five-year rule also applies to conversions. You cannot withdraw the converted amount in your Roth IRA until five years have passed.

8. There are no required minimum distributions during the life of the Roth IRA owner

For some folks, required minimum distributions (RMDs) are a big problem with retirement accounts. This is a minimum amount that the IRS says you have to withdraw from your retirement account each year once you reach a certain age. With some accounts, like 401(k)s, this can be disheartening, since the RMD can add to taxable income, possibly putting you in a higher tax bracket.

However, with a Roth IRA, there are no RMDs. The owner never has to withdraw money if he or she doesn’t want to. It is important to note that this privilege disappears upon the death of a Roth IRA owner; heirs to the Roth IRA must take RMDs (but the RMDs are still tax-free). Inheriting a Roth IRA is very similar to receiving the proceeds of a paid-out life insurance policy.

The bottom line for Roth IRAs

The Roth IRA is growing in popularity because it offers many benefits without several of the drawbacks associated with other retirement accounts. In addition to the information noted here, the Roth IRA allows for contributions for the remainder of your life, unlike the traditional IRA that restricts you from contributing after age 70-1/2.

A Roth IRA can be a great savings tool. Just make sure you understand the Roth IRA rules that come with it, and be careful to adhere to them.

Money you roll over from a 401(k) to an IRA can be a traditional IRA or a Roth IRA, depending on whether you pay tax at the time of rollover. If you simply move the 401(k) money to IRA without paying taxes on it, then it is a traditional IRA.

If all of your 401(k) contributions had been pre-tax, then you’ll have a big tax bill when you convert to a Roth IRA.

What do you suggest people should do to optimize return on 401(k) to Roth IRA conversion?

Another way to minimize the tax burden is to pick and choose when you roll over certain portions. If someone loses their job or has a significant reduction in income that would be an ideal time to do a conversion (full or portion) since they can take advantage of being in the lower tax bracket.

This is correct (assuming the education expenses are “qualified higher education expenses”). In addition, these are both acceptable ways to get money out of a traditional IRA prior to age 59.5 without paying the 10% penalty.

For those planning for an early retirement, being able to withdraw the principle could be incredibly helpful. My plan calls for using that principle as living expenses for several years, until the other revenue streams kick in.

You’ll see that the “series of substantially equal periodic payments” appears there as one of the exceptions.

Note also, however, that you’re allowed penalty-free distributions from a 401(k) starting at age 55 (rather than 59.5) if your separation from service occurred in a year in which you turned 55 (or older) — the advantage to this over the SEPP route being that you’re not locked in once you start.

I’m personally not a big fan of 72(t), especially if you can avoid it. Mike brings up a good point about early distribution rules starting at 55.

I’ve had clients that have locked in 72(t) during the last 5 years and you can imagine how chaotic that has been with the ups and downs of the market. Locking yourself in for any extended period of time, can leave you vulnerable, IMHO.

Also, it is possible that income tax rates will either be the same or higher (even after considering a smaller need for income) in retirement for those retiring 10, 20 or 30 years from now. This diminishes the value of the traditional IRA.

I’m a CFP and I don’t think I’ll ever contribute to a traditional IRA again in my lifetime. I use ROTH.

They’re in your Roth 401k, but are taxable upon withdrawal. Roth 401ks seem like they’re a bit of a logistical nightmare because you account for a portion of it to be taxed and a portion to be untaxed.

I think it might depend on the company? My husband has the option of a regular 401K AND a Roth 401K, but in order to have the Roth 401K he must also have a regular 401K and that’s where the company contributions go regardless of how he divvies up his own contributions.

I am the Owner of a small business where my wife is the only other employee. We use a ROTH 401K and a Traditional 401K. We make post-tax contributions up to the 401K limit and then our company can match up to 25% of our salary into the traditional 401K. The greatest advantage of this over the ROTH IRA is there is no income limit. With the IRA you must make under a certain amount. Anyone can participate in the ROTH 401K. We found a very good provider to help us set ours up. They charge 1/2 percent per year as an administrative. fee. We hold the accounts in a brokerage in “Custodial” accounts. The plan provider gives us all the plan docs and help us set up the accounts – but he has no access to them I can invest in anything I chose to, that the brokerage allows. Mainly I invest in ETF and some stocks. I honestly think its better to pay taxes now, at these tax rates, than later at who know what rates.

I like the idea of being able to pull out the principal without penalty. Any chance the government in thier need for more and more money could make withdrawals taxable in the future? I would also be interested in Roth 401k information as this is what I contribute to at my employer. Thanks for the great info!

I took a class on tax policy last semester for my Masters of Taxation degree and did my research paper on Roth IRA versus Traditional IRA. My research showed that the future taxability of the Roth IRA is uncertain. There could possibly be a tax administration in the future that could tweak the wording of the code so that maybe part of the “tax free” distribution could be taxable in the future.

With that being said and the additional research that I did, I am sticking to traditional IRA and taking the tax deduction now. The future of the code is too uncertain for me to pass up a tax break now for one that may or may not be there in the future.

The Roth 401(k) has a lot of the same tax treatment of an IRA, plus the benefit of significantly higher contribution limits, but there are two major factors to consider.

1) The crappy investment options your 401(k) might have.

2) The PLAN (not the IRS tax code) may not let you take distributions. This is probably to keep more money under their management.

I would definitely go Roth IRA first, and then any extra after-tax contributions to a Roth 401(k).

I tend to split, for now, pretty evenly between traditional and Roth. In my opinion, despite what Obama might be pushing for in the short-term, I don’t necessarily see rates going up. It seems much more likely to me that with all the “tax reform will save our economy” rhetoric coming from the right plus some of the quasi-agreements that have happened, that rates lowering plus removing deductions is most likely, at least in the short-run.

Lastly, remember, in retirement you’ll likely have your house paid off and won’t be “setting aside” savings anymore. Further, social security is only 0-85% taxable, and payroll taxes (7.65% of your gross income) will no longer be sapping your cash-flow, so your cash-flow in retirement will most likely a decent amount less than during your late working years, and likewise with your tax rate if they stay the same.

One other thing to consider with your existing retirement plan is not only when the investment options suck, but also if there are surrender charges involved.

For example, I recently had a client that left her job and was wanting to roll her retirement account (she had a Simple IRA not a 401k)into a Traditional IRA. She had been working there for almost 7 or 8 years.

Unfortunately, her employer had used one of those big bad insurance companies as their retirement plan provider and she was in some sort of annuity product.

In a nutshell, she had to pay a 6% surrender charge to access all of her money OR wait 6 years before she could get all her money penalty free. That’s ridiculous!

If you’re starting a job that you’re not sure if you’ll be there a long time, make sure you check up on this. Even with a nice match (which she didn’t have) she probably would have been better doing a traditional (or Roth) IRA instead of paying the penalty.

IMO, over-Rothing is one of the biggest mistakes many investors make. One thing I hear over and over from recent retirees is that they dramatically overestimated their retirement tax bracket.

My rule of thumb is that unless you:
a) need access to the money well before age 59.5,
b) expect to have a pension in retirement,
c) expect to continue working in retirement, or
d) already have a giant pile of tax-deferred money

Thanks for the clarification, Mike. I had read it as “put money into your 401K, and then if you still have money left over, put some into a Roth.” Across all our retirement accounts we’re about 80-20 between the 401Ks and the Roths at the moment, but if you only look at my retirement accounts it’s 40-60 in favor of the Roth because I’ve only had access to a 401K in the last two years.

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Dansays:

15 September 2011 at 7:05 am

I guess, taking this “roth” discussion one step further, we should maybe examine the taxpayer’s goals AFTER age 75-80.

Once you hit 80, your RMD’s start to get pretty darn big, and by 90, they’re huge.

This could very well push someone into much higher tax brackets in later retirement than they’d otherwise want to be.

Further, any roth or IRA transferred to your kids has to be distributed to them over their lifetime given RMD rules, and depending on their tax situations, you might be handing them an IRA with a high “implied tax liability” attached to it.

All else being equal, having a pension will put you in a higher tax bracket in retirement than somebody without one.

There are plenty of exceptions, but the general rule for Roth vs traditional is that if you expect to be in a higher tax bracket when you withdraw the money than you’re in when you contribute the money, a Roth is a better choice.

Pensions are taxable. So a Roth lets you diversify and have some of your money pre-taxed.

I don’t know about other people, but if I were getting my (predicted) pension right now, I would be in the 15% tax bracket. I can’t imagine getting enough raises in the next 3 years before I retire to even get my full pay above the 15% bracket (after deductions), let alone my future pension.

I can, however, imagine tax rates going up. Look at the history of tax rates. And look at our national debt. I feel pretty sure taxes are not going down. (I’ve been wrong before about that, but not very wrong.)

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Stevesays:

15 September 2011 at 9:55 am

I totally agree. I suspect it is due to the psychological bias towards “free” things. Most people will NOT be in a higher tax bracket when they retire.

There is also
f) Are already maxing out tax-deferred retirement accounts.

Mike’s (d) is “already have a giant pile of tax-deferred money” which is not exactly the same thing, though it is similar (e.g. if you may out tax-deferred accounts over time, you will end up with the giant pile of tax-deferred money).

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Dansays:

15 September 2011 at 6:46 am

I think for MOST people, putting 2/3 into IRA and 1/3 into a Roth as a “simple rule,” and modifying that as they get closer to retirement and have a clearer view of their net worth, cash flows, and tax laws, they’ll be in a great spot.

My only hesitation with over-doing the Roth is the realization that when my house is paid off, I’m no longer having to set aside savings every month, my SS is only partially taxable, and my wife and I aren’t paying 7.6% of our gross income into FICA & medicare, I’m likely to be in a lower tax bracket based on required cash flows.

Past performance is no guarantee of future results.
If anyone has a Healthcare Savings Account, you know how easily the rules governing tax sensitive accounts can change. It is easy to see the attempts to eliminate these accounts included in the health care reform act.
I have no confidence that the government will be able to keep the promise not to tax earnings on Roth IRA’s. I am contributing some retirement funds through a Roth, but most contributions are tax deferred through a 401(k). I know the tax benefit I am receiving today (via 401(k)), but am not certain the tax benefit will exist 35 years from now (via Roth) when I need to use it.

The change to HSA’s was trivial. How much did you really spend on OTC stuff? I don’t take that as proof that the government is going to change the rules at a whim. Roth accounts are not some government conspiracy to tax us now and then again later.

I suspect the reason Roths were invented was so that the politicians could get tax revenue this year instead of some future year. (Getting it this year means they can spend it and get themselves reelected.)

In physician co-pays, family eye care, prescription copays, orthodontics, etc. I spent several thousand in medical care each year. Since HSA accounts can only be paired with high deductible plans, I paid for medical care almost entirely out of pocket for several years.

My employer changed insurance back to a more traditional PPO plan and offers an FSA. I am no longer sure about HSA accounts, but FSA accounts have a scheduled reduction of the contribution limit from $5000 to $2000 starting in 2013. This is the significant change to which I am referring.

I don’t believe that Roth IRAs were invented as part of some great government conspiracy. However, we evidently differ on opinions of the degree of trust which the federal government deserves.

The FSA change may annoy you, however it is not retroactive. Of course the rules may change in the future; they change all the time. The Roth didn’t even exist as an option 15 years ago. 25 years ago credit card interest was tax deductible. That’s not the same thing as the government not living up to it’s promises. I am not saying it can’t happen, just that your example doesn’t prove it.

I don’t trust the government, per se, however I model it as a collection of individuals politicians looking to get reelected. As such I am dubious that Roths will ever be taxed directly or in an obvious, indirect way (e.g. switching to a national sales tax instead of an income tax).

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Debbie Msays:

15 September 2011 at 7:56 pm

Exactly. All the money you put in there before is still tax free. I can see people phasing out the Roth IRA, but I really don’t think the money you’ve got in there will be subject to different rules later. And they’ve already taxed your contributions–I really don’t think they’ll double tax you. EXCEPT by making a national sales tax. And with a national sales tax, you’d pay that regardless of which kind of IRA/401K you were withdrawing your money from.

Also, my experience has been that when rules change for retirees, people who are already retired (or close to being able to retire according to the rules) get grandfathered.

Tax rates were pretty crazy in the 1970s. How did they get that way? I don’t know, but I bet it could happen again, especially if health care gets socialized. And it’s even worse in lots of other countries.

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Corinnesays:

15 September 2011 at 7:36 am

I”ve been mulling over this, and it seems to me that contributing to a Roth when you are first starting out in your career and in a low tax bracket and then transitioning to 401k when your income increases might get the best balance of both vehicles. I would hate to pay a higher tax rate on some of that Roth money if my tax bracket is higher right now than it would be in retirement.

Hopefully, if you are in a high tax bracket, you are able to max out both the 401k and the Roth IRA. If putting $16,500 in a 401k and $5,000 in a Roth is not something you can do, then you are probably not in a high tax bracket anyway.

For “little known” facts, a lot of these seem to be common knowledge to me. A truly little-known fact that was not mentioned, and applies to both Roth and regular IRAs, is that they can be invested in pretty much ANYTHING. In fact, the laws only list the few things you CAN’T invest in, such as collectible artwork or coins, personal residences, and a few others. However, you can use a Roth IRA to invest in real estate, notes, private equity, or pretty much anything else through a “self-directed” IRA.

I agree with this – the title is a misnomer. I always feel kinda tricked when authors come up with catchy titles, then just provide the same well-known information over again. I stopped reading CNN daily for that reason.

I also agree that self-directed IRAs and the 72(t) rule are lesser-known IRA facets that would have been prime material for a post with this title.

Also agree that many of these are pretty widely known. I’d have like to have read more about the Roth IRA as an inheritance vehicle. (See “The Smartest Retirement Book You’ll Ever Read” – the author advocates holding on to your Roth as long as possible because of the tax-free RMDs for heirs combined with compound interest)

I doubt that the specific tax benefits that Roths get will change (tax free withdrawls), but over the next 20-30 years, it’s easy to guess that there’s at least a chance that a new tax system will get put into place, where you pay taxes at time of purchase.

In that context, you’d pull out your earnings tax free, then immediately pay taxes on them when you go to actually spend. Effectively ending up with that money getting double taxed (once when put in, once when spent) — meaning that the Roth IRA just turned into a normal “taxable” account.

Moral of the story: diversify your tax risk, just like any other risk.

Right – it’s not an income tax, but over the time frame of 20-30 years, the bulk of taxes could easily shift away from income tax, into something else like a VAT, or Sales tax, which would hurt the benefits that Roth accounts propose.

So yeah, split savings across different types of tax advantaged accounts.

Question about the income limits for contributing: is this gross income or taxable income (for married filing jointly). This always stumps me when people discuss tax policy (such as “raising taxes on those making more than $250K/year). There’s a big difference between what you earn as a salary and taxable income.

Regarding what others have said about the “permanence” of the tax-free withdrawal: I’ve already paid taxes on the money I contributed to the Roth. I think there would definitely be a challenge if anyone in Congress decided that taxing upon withdrawal was a good idea. Not saying it won’t happen, but it seems like that would be an issue for them. This isn’t quite like changing the rules for HSA.

With regard to Roth contributions, it’s “modified adjusted gross income (MAGI),” which is neither gross income nor taxable income.*

In this particular case, MAGI means adjusted gross income (the bottom line of the first page of your 1040), with a few adjustments — adding back any student loan interest deduction, any deduction for a traditional IRA contribution, any tuition and fees deduction, and a few other less common ones.

I love my Roth IRA and right now, as a grad student, my tax rate is probably the lowest it’ll ever be so it’s worth investing in a Roth. If we had more money, I’d also invest in the TIAA-CERF accounts open to us, but alas, funds only go so far.

I am disappointed that the government excludes students from getting the saver’s credit – that seems to be counterintuitive since students (at least graduate students) need all the extra help they can get and are at the best point in their lives to save!

I do hope the Roth won’t be taxed in the future, but I do keep that in the back of my mind! I also plan on diversifying more once more income is made. Don’t depend on one place for all your retirement.

Make sure your income is “earned income.” My fellowship isn’t considered earned income, which is required to be able to contribute to any sort of IRA. An easy way of figuring out if your income is considered “earned” or not is if you pay Social Security taxes — if you do, it’s probably earned income. If you don’t, it’s definitely not and you’re not eligible to use that money for an IRA.

While true, I don’t think many graduate students are married to a working spouse and filing jointly. And many of those who are are married to other students.

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katesays:

16 September 2011 at 12:39 am

I’m not saying that you are wrong about your own personal situation with the fellowship, but I would like to present a situation that seems very similar on the surface but was actually very different, tax-wise.

I received a stipend as a graduate student, and it WAS considered earned income for Roth IRA contribution purposes — I actually asked a financial planner about this, and she told me that the fact that it was reported on a W2 (not some other form) was what made it “earned income.” It is not about whether social security payroll taxes are withheld.

There are many people who have earned income but are not required to pay social security taxes. Many graduate students are exempt from social security taxes when they earn money as part of a training program. I actually looked into this because I wanted to understand it, and it seems there is a law called the federal insurance contributions act that determines whether student workers pay social security or not. The gist of it is, if you are required to do work as part of your training program, you don’t have to pay social security payroll taxes. For example, I was paid to be a teaching assistant, which was required for my degree (no TA experience = no degree). So, the U. didn’t withhold social security taxes during the school year. They made that choice, probably based on federal law. It is actually fascinating, and there have been some recent legal changes w.r.t medical residency as to whether they are exempt from social security. Other groups, like public school teacher employees in CA, don’t (normally?) pay social security payroll taxes. Their income is reported on W2 forms (at least the teachers I know) and is certainly considered earned.

So there can be some major tax differences depending on each individual situation, even when the situations look very similar (and a graduate fellowship can be very similar to a research assistantship, as we know). I’m posting all this because I don’t want graduate students who read this to automatically assume that they aren’t earning income if social security isn’t withheld from their paycheck. That is not necessarily true. Your income can still be earned and you still might be able to have a Roth IRA.

I think a better rule of thumb would be that if the money is reported on a W2 as earned wages, it will likely be considered earned income, regardless of whether you are exempt from social security payroll taxes or not. Of course a tax professional could probably explain this much better than I can, but I thought I’d share my different experience with grad school stipend income.

You’re right, whether or not you get a W-2 is a better rule of thumb. As for me, I don’t get one, and thus none of my fellowship is considered earned income. What’s fascinating to me is that at my institution, how graduate students are paid depends on where the funds to pay them come from. If the money comes from the NIH, it’s considered earned income (and they have to pay Social Security taxes), but other funding sources don’t require this. My fellowship previously came from a private foundation and now from the state of California, but sadly neither one is considered earned income.

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Timsays:

16 September 2011 at 8:34 am

Oh, and you’re right that there are certain groups (usually public employees of certain states) that don’t pay into Social Security, but instead pay into their own pension system. But those groups opted out of Social Security, rather than not being eligible for social security.

Either way, my first rule of thumb was just talking about students. I’m not sure I can think of any “real jobs” that aren’t considered earned income.

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Golfing Girlsays:

15 September 2011 at 9:21 am

I would certainly hope the American people would never stand for Roths being taxed in the future, as double taxation is illegal as far as I know.

I love the Roth and look at it not only as a source of retirement funds, but as college savings and emergency fund savings as well (it would have to be a SEVERE emergency for me to touch it though). This will be the first year we haven’t maxed out our Roths and I’m a little sad. But being a stay at home mom has been worth it.

There are lots of types of taxes. I don’t think a national sales tax would get the kind of anger (specific to roth) that a “ohh, pay income tax now” decision would. Even though in the end, you’re paying taxes on “tax free” money.

I don’t think people would fall for it, though. It is possible that there could be enough voters without Roth’s at some point in the future, that they could get away with it (vote to take money away from those “rich” people). On the other hand I think that between the allure of the word “free”, and poorly considered advice such as the above and Tent Hamm’s neverending beating of the Roth drum, many people do have Roths (including many for whom it is inappropriate – including some people commenting on this thread!)

It’s also possible that some future government will choose to sieze all IRA balances “for the good of the people.” You never know. Investing in anything but nonperishable food and the guns to defend it is always a risk.

I think one issue not raised here is whether you are maxing out your IRA/Roth contributions. If you are, then the same amount in the Roth account is going to provide you more money in retirement.

In a traditional IRA (or 401k) a portion of the money you save actually belongs to Uncle Sam. As has been noted, the government will get its share, including earnings, based on your tax rate when you take it out.

So $5000 in a Roth will yield $5000. $5000 in a IRA will only yield $4250 if your marginal tax rate during retirement is 15%. If you want to achieve the same savings with an IRA, you need to put your tax savings into a regular savings account.

As for taxing withdrawals from a Roth, that will never happen any more than we will tax withdrawals from regular savings accounts. Its more likely some politicians will decide to NOT tax your traditional IRA withdrawals. The VAT or some other form of consumption tax are the most likely way federal taxes would be changed to eliminate the difference between the Roth and traditional IRA.

One other thing to remember. Taking a distribution from your Roth is permanent. You can’t repay it. And you can’t make contributions in the year you withdraw it. In most cases, you are probably better off borrowing the money you need rather than taking it out of your retirement funds.

I’m about to go into my company’s 403b plan. I’ve been here a year and my company is contributing 5% if I contribute at least 5%. My brother is a financial planner and he said that there are more investment options with traditional IRAs. I’ve decided to go with the traditional because I need the tax savings now and I don’t make that much. My situation is a little different in that I’m 54 and don’t have any retirement savings. I used to but to make a long story short s**t happens.

Thanks Dan. Yes I am definately going to contribute %5. Once I get a part-time job I’ll be putting in more. My goal is to be able to put in the max for ppl over 50. I may not be able to do it this tax year but def from the next year.

That actually might be a good thing to pass on the 403b. With the change in 403b regs a few years ago, we’ve seen a lot of mutual fund providers dropping out and mostly insurance companies with annuity products being the only options. In one such case, a prospect I was talking (who is similar age to you) was duped into one of these and had a 10 year contract period attached to it. Insane!

The savers credit is something I didn’t know about, might just qualify for the 10% bracket. The caveat is that my wife is a full time college student, and if we don’t file jointly I would probably make too much on my own to qualify as head of household.

That’s also interesting what Ross said about not being able to make contributions in the same year you withdraw contributions. I’m still seriously considering moving most of my emergency fund into my Roths this year to max them out though. .99% in an Ally Money Market account is just too much of a joke to leave it there

“If your income falls beneath the threshold for your filing status for the year, you must also make contributions from taxable compensation. This means individuals can not use rental property payments, royalties, or other non-taxable compensation to make contributions to a Roth IRA. ”

I am confused by this. I thought you could only contribute to a Roth IRA if you received earned income like wages. Income from pensions, interest, dividends etc did not qualify. I know I can convert some of my 401(k) money when I retire to Roth IRA, but since I will be retired I am no longer earning wages. However, when I retire, I will receive a pension (taxable), Social Security (taxable for me because of my high income) and 401(K) withdrawals, (taxable because they were tax-deferred). Yet I would not be able to still “contribute” to a Roth IRA would I? I know I can “convert” some of the 401(k) but that is different than taking some of my pension income and contributing it to a Roth IRA. I think clarification is needed on what type of income allows you to contribute. Whether it is taxable or not is not the issue, is it? And why are rental property payments not taxable?

Can you contribute the max $ to receive company match to a 401K and also contribute up to the limits for a Traditional IRA and a Roth IRA ($16,500 and $5,000, respectively)? Or is there a maximum you can contribute to any combination of these retirement accounts (ie. Would you have to deduct the amount you contribute to the 401K from the max you can contribute to the traditional IRA)?

You can definitely contribute to both. What will start to affect how much you you either contribute or get a tax deduction for is your income limits.

For example, if you exceed the income threshold (see above), then you won’t be able to contribute to the Roth. Keep in mind, however, that by contributing to your 401k, you are actually reducing your taxable income that might make you able to contribute to a Roth IRA. (I was actually able to do this a few years ago).

Regarding Traditional IRA’s, you can always contribute the maximum to them BUT…if you are covered by a existing plan, you might not get the full tax deduction for contributing.

With no tax deduction, many don’t even bother although the money does still grow tax deferred.

Decisions about investments in a Roth are the same as any other investment. What is your timeframe for spending the money.

The term “emergency fund” is used in a lot of different ways. Some people see it as sort of like life insurance, used only in the extreme. Others see it more like car insurance, a fund that gets used for “emergencies” like replacing the furnace. And others see it as more like health insurance, used regularly for small emergencies.

There is a built in conflict between the investment strategy for retirement (in 20+ years) and one that is appropriate for an emergency fund of any kind. If your ROTH “emergency fund” is in that last category, then you should probably invest in a money market fund. Its really a cash reserve. But even in the other two categories, you probably want a very conservative mix of investments.

The one thing that scares me about Roth IRAs is the risk of the government going to a value added or fair tax (either fully or in addition to the income tax). If that happens, my earnings will get taxed twice.

Since I’m only 26 years old…a lot can happen between now and when I retire. Who know what taxes will be in 40 years or how they will be collected.

With a traditional IRA I get my tax benefit now, which can be invested and compounded. The gap between the tax benefit of a Roth and a traditional isn’t all that large if you do it right, but it takes out all the risk of tax changes out of your control.

I don’t see them adding a VAT and then dropping the income tax. In which case, people with regular IRAs would also be double-taxed (once when they withdraw the money and again when they spend the money).

Great points, I’m always correcting misinformation (especially this point: The Roth IRA can be used for other savings goals) that I hear at work. Ironically, I work at a financial firm, so I’m always shocked to hear such misinformation.

I think it is important to remember that the government is no more likely to act in a way that adversely impacts having a Roth IRA than it is to adversely effect traditional IRA’s. For instance, as someone pointed out, a VAT would apply to money spent from those or any other source.

I think hardly anyone under 30 should be saving for retirement unless their employer is matching their money. But a Roth is a way to save money that you may or may not need without tying it up until age 59. If it turns out you never need it, great, you got a head start on your retirement fund.

I am currently unemployed but do not receive unemployment or any other financial assitance, as I am currently being supported by my spouse. I have some money in savings that was already taxed as income when I first earned it in years I was working. Can I contribute to my Roth IRA from my savings this year, even though I didn’t earn the money this year?

You can’t contribute to a Roth IRA from savings. But your spouse can make a contribution for you, assuming they have enough earned income this year, and you can take the money out of your savings to make the contribution.

How to convert 401k into Roth IRA? Is it worth it?
I recently graduated college and have a small Roth 401k account with my company. My company participate in a ROTH 401k matching program. I believe every 1$ I contribute (aftertax), they contribute $1 (before tax). I was told that it is a great time to convert my 401k into a Roth IRA because 1) i am in the low bracket 2) i wont need to pay as much taxes as my investment is a little under water. Therefore it is a great time to convert.

Questions
1) Am I allow to convert if I am still with the same employer or I would have to leave?
1) If i do convert, will this add to my gross income? What portion? I assume the taxable amount (company match)
2) What are the steps to convert needed to convert from my company Roth 401k to IRA Roth?
3) I know there is a 5000$ limit on the amount I can contribute to the Roth IRA, does this include rollover also? What portion will be part of the 5000$ limit? I assume the taxable amount (company match)?
4) This rollover, will this be consider a contribution where I can always take out the money or be consider part of earnings? I assume my portion that I contribute to the Roth 401k will be consider contribution into the account, but how about the company’s match? Am I allow to take this out anytimes as this is a contribution from the company?

I don’t know the answer to all of Allan’s questions, but he raises an excellent point that relates to “tax diversity” and age.

Most people are going to move into a higher tax bracket as they get older. That means the tax deferral from a traditional IRA has a larger benefit. On the other hand, when you are in a very low tax bracket the Roth contribution is taxed at that lower rate.

So if you are looking to have “tax diversity” in your retirement funds, putting money into a Roth when you are younger and in a lower tax bracket makes sense. As you get older, you can add money to your tax deferred accounts to create tax diversity. Tax diversity has no practical consequences until after you retire and start taking money out. It doesn’t really matter when you contributed the money.

Every one pays tax.Well there are some exceptions to that.I am not in numbers but i know how to handle money wisely.Almost all of the people in United States have credit cards.Just a couple years ago, credit cards were the weapon of choice for most American customers. The Good Recession of 2008 changed all that. The use and balances of credit cards by American customers has fallen drastically in the last three years. And while that may be smart and responsible from the standpoint of personal finances, the good sense of these consumers does have a negative effect on a shaky economy that runs on credit. That is a practical policy from the perspective of finances. But in the large picture, it might well hurt the economy. Source of article: Economic growth depends on spending and paying bills on time Everyone must responsible in terms of spending their money.Only buy the things that you need and not the things you want becuas if you but the things you want you can find yourself spending too much.And buy only the things that you’re sure that you can pay easily.And it is also practical to invest on something that you will benefit a lot for a long time.

Question on Roth IRA’s.
Can it be used to buy stock in a Private Company.
My friend is launching a new venture and has offered to sell me 1,000 share of stock in it for $1,000.
Can I put some of my Roth IRA money into it and how do I hold the stock if allowed by the Roth IRA plan.

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